Tax Reform’s Potential Impact to Restaurants

Late last week the House of Representatives unveiled a first draft of the long-awaited tax reform bill, the Tax Cuts and Jobs Act (TCJA). At a high level, this bill seeks to reduce corporate tax rates, limit the number of income tax brackets, modify or eliminate a variety of itemized deductions, repeal the estate and alternative minimum taxes and change the taxation of foreign income. The Ways & Means Committee plans to formally markup the bill starting November 6 for full House floor consideration before Thanksgiving—a tight legislative timeline.

The bill, from a high level:
Under the proposed plan, the corporate tax rate would be reduced from the current rate 35 percent to 20 percent. In addition, certain “business income” from pass-through entities would be taxed at 25 percent rather than an owner’s individual rate. The bill would also repeal the corporate alternative minimum tax (AMT) and make existing AMT credit carryforwards refundable over a period of five years.

What’s at stake for the restaurant industry?
In the legislation’s current state, the repeal or rollback of several key credits and incentives could put restaurateurs under pressure, potentially outweighing the benefit of a reduction of their corporate tax rate. While the bill markup and the eventual transition to the Senate side could result in many changes to the legislative language, there are several important provisions for restaurateurs to keep in mind.

FICA Credit
First, restaurant companies should be aware of the proposal to modify the FICA tip credit. As restaurants with tipped employees know, this is one of the more valuable tax benefits currently available. The FICA credit was originally enacted as a way to reimburse restaurants for a portion of the social security tax required to be remitted on tips reported by tipped employees. 

Under current law, the FICA credit is computed with reference to the 2007 federal minimum wage rate of $5.15 per hour, which was frozen into the tax law for tax years after 2006. Tips eligible for the FICA credit are those in excess of what’s needed to bridge the gap between the amount employers pay their tipped employees in cash and what they would pay them in cash if minimum wage were $5.15 per hour. The use of a frozen $5.15 for purposes of the FICA credit computation ensured that the FICA credit was not reduced every time the actual minimum wage has increased since 2007.

Should the draft legislation pass, the FICA credit will no longer be computed with reference to the 2007 wage rate of $5.15 per hour. Instead, the credit will be computed by reference to the current federal minimum wage in effect each month during the tax year. As a result, restaurants can expect a lower FICA credit, since more tips will be needed to bridge the gap between cash wages paid to tipped staff and the current minimum wage. If the bill becomes law, all restaurants that claim the FICA credit will be required to comply with annual tip reporting requirements (i.e., completion of Form 8027).   

WOTC Credit
Another aspect to the bill restaurateurs should be aware of is the proposal to repeal the Work Opportunity Tax Credit (WOTC). The current law allows restaurants to claim a federal income tax credit for a portion of salary and wages paid or incurred to eligible employees who begin work for the company before January 1, 2020.
Following passage of this bill, this credit would be repealed.

Section 179 Expensing
Under the current law, restaurants can expense up to $500,000 of the cost of qualifying property placed in service during a given tax year. This amount starts to be reduced if the total amount of assets placed in service exceeds $2,010,000, and is eliminated if the total cost of eligible property placed in service exceeds $2,510,000.

The draft legislation of TCJA proposes that these dollar limits be increased to $5,000,000 and $20,000,000 for taxable years beginning after December 31, 2017, and before January 1, 2023, with plans to index for inflation. If enacted, this means that restaurants could expense up to $5,000,000 of asset additions in a given tax year, a favorable aspect of reform. Note that there are taxable income limitations and other nuances that apply, and as a result, not all restaurants will be eligible to expense the full $5,000,000 in any given year.

Other, more wide-reaching aspects of the bill we’re keeping our eyes on include the proposed repeal of the Domestic Production Activities Deduction (DPAD), a limit on 1031 exchanges to real property only and potential changes to pass-through entities.

Next steps
The release of the House bill represents the first significant and detailed legislative step toward tax reform under the Trump Administration. As drafted, most of the provisions would be effective for the 2018 tax year. 

As we look ahead to the end of 2017, restaurants should take advantage of current tax benefits while they are still available and can help offset 2017’s high tax rates. These benefits include bonus depreciation, section 179 expensing, the WOTC credit and the FICA credit. It’s also important to keep in mind that the bill is still in draft format, and nothing is set in stone. For now, proceed with business as usual, executing short-term business priorities under the assumption nothing concrete will pass until the end of the year.

Contact Adam Berebitsky at aberebitsky@bdo.com and Lisa Haffer at lhaffer@bdo.com with any questions on how tax reform could impact your business. We’ll be sure to update you here, as more information arises.

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